APPENDIX

Transcript of Discussion Held on August 2 2 , 1983 CHAIRMAN VOLCKER. [This is] a discussion, not a meeting of
the Federal open Market Committee. I circulated [an outline]
containing some general questions. [Secretary's note: A copy of the
outline is attached.] The first part was more general than the second
part, which is essentially procedural. These questions, both
conceptual and procedural, keep arising in my mind as I sit here in
the meetings and when I have to traipse up to Congress and discuss
them. And I thought we might usefully open up the discussion--Idon't
suppose we'll attempt to come to any particular conclusion today--and
see whether we want to carry it on more elaborately or more precisely
at some later date.
I think the easier issue to get a grasp on is the procedural one, so let me take that up first. I have had a feeling for some time that this process of making an elaborate and formal projection every
six weeks has its limitations. I sit around at these meetings and,
speaking personally, find the discussions on the business outlook
often less provocative than they might be. Therels perhaps a certain
natural passiveness [in the tendency] to discuss the outlook only in
terms of the staff forecast, which is usually brilliant and solid, but
that [practice] is not in itself conducive to the expression of
strongly conflicting views that should be explored.
There are two proposals [in the outline] under number 2 ; let me bring up "b" first and then go to "a." And "b" and "c" are part of the same process. We don't have to reach a conclusion on this today. Would it be a good idea to have a procedure where we would have a staff forecast fully articulated, the way it is now, let's say at the
beginning of every quarter? We meet, what, eight times a year? So,
four times a year, if my arithmetic is right, we would have the same
[type of1 forecast as we do now. And when we meet in the middle of a
quarter, we would have a staff presentation that would discuss the
outlook as we do now, but it wouldn't have to be a fully articulated
forecast. The staff could say they feel a little better about things
than they felt last time or a little worse and give the reasons. But
we'd provide an opportunity for a different view to be expounded, not
just for the sake of being different. It could take several forms.
[It could entail1 the development of some aspect of the economy,
either short run or long run, that otherwise wouldn't get the same
amount of attention, or an alternative forecast which could come from
within the Federal Reserve System, either by the Washington staff or
staff of one of the Banks. Or indeed, it could be a presentation, as
someone suggested to me, of outside forecasts--areview of a variety of outside foxecasts so that we are sure that we are being exposed to outside thinking. I have not thought of anything so radical as having an outsider come into the meeting to expound the forecast, but we could be presented with an interesting forecast or a range of forecasts from outside to put a little different angle or twist on the discussion of the business outlook. I don't think I have anything much more complicated than that in mind in the thinking that I've done

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about it. But we might just discuss this a bit. It will be brand new to some of you and I don't think we have to reach any conclusion. But my point of departure is: How useful is it to have a full scale staff forecast every six weeks as opposed to, let's say, once a quarter, which is going to set the framework for the targets for the quarter
and what we have in borrowing?
Well, I find Ian updated1 forecast every six weeks very useful because the constant flow of information gets incorporated into it as we move along. And occasionally, we get a rather major change in the forecast. For example, not this quarter but the one before the forecast changed rather sharply as a result of incoming data. I think it does utilize the full range of expertise that we have in the System. As for outside forecasts, I get enough already. They are literally pouring out of my in-box practically every week. So, I see almost all of the other forecasts and I'm not sure that having a summary of what is being forecast on the outside is going to add much to the information that I have so far.
MS. TEETERS.

WALLICH. I share Nancy's feeling in that I'd like to see updates. Now, whether we get the full [package] with the model printouts--nobody can read that anyway--[isn't critical] but the major changes in the rate of growth and prices are. For instance, if we hadn't had a six weeks updating of the forecast, it would have been
quite hard to follow the sudden surge of the economy this year. We
might now just gradually be catching up with the GiW numbers that are
being published.

MR.

CHAIRMAN VOLCKER.

That I find a little difficult--

MR. WALLICH. As for outside forecasts, I don't know of any that is sufficiently different from ours to be very meaningful. A survey of where others stand and where we stand within that spectrum of others I always find interesting. And I try to get myself data of that kind. It's certainly not difficult to do, but it might be interesting to do it here.

MR. GRAMLEY. I wonder if we couldn't achieve in any event most of what you want, Mr. Chairman, with relatively minor changes in staff presentations. I find quantitative forecasts very useful. There are times when a change in one's perception of what is going on in the world happens. In my case, I have become aware in the past six weeks of a lot of qualitative evidence that the slowdown in housing is going to be larger than I thought it would be. So, I'm inclined to ask myself the questions: what does this mean? HOW much is it going to slow down the economy? How do I need to take this into account?
Those are the kinds of questions the staff is continually trying to
address in making a quantitative forecast. The staff presentations we
do get I would hardly call recitations of detailed quantitative
forecasts. They're inclined to be interpretive. Maybe we could ask
the staff to go a little further in that direction in the meetings

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other than the quarterly ones. I don't see that there's any need for
a basic change in what the staff is presenting to us.
VICE CHAIRMAN SOLOMON. Probably what we should improve is
the quality of the discussion after the staff forecasts. I don't know
how to do that.
CHAIRMAN VOLCKER. That's part of the effort here. I'm not
sure we get that when the staff [has presented a forecast]. It's very
easy to sit here and say "Well, it might be a little higher or lower
than the staff forecast, but the forecast is all right." That is the
typical comment from each member.

MR. PARTEE. Maybe we could have the discussion before the staff presentation. I think it's pretty hard to do it halfway, Paul. The staff, contrary to general belief, does not have a model that they just grind out. What they do is put together their best efforts [to develop1 a judgmental notion of the outlook and go through the whole
iteration. Whether or not they disclose it to the Committee, they are
going to have to do it every six weeks if they have to give us
highlight information every six weeks, so-­

CHAIRMAN VOLCKER. That's not my problem. My objective is
not to make the staff work less hard. It's to get a fresh point of
view occasionally.

M R . RICE. I guess I'm in the minority with the Chairman. I think the fact is that the forecast doesn't change that much most of the time over the period of a quarter. And since it doesn't change that much, just a judgmental updating during the meeting in the period between quarters would be enough. It would be enough for me. M R . PARTEE. well, that's precisely what we get. M R . RICE.
MR.

No, we get a full quantitative forecast.

PARTEE. I call that a judgmental updating. RICE. Well, without the numbers.

MR.

Well, you have to make sure that the assets and liabilities match. After all, a double entry bookkeeping system imposes some discipline; you have to run through it. That's one comment one would have about their forecast this time.

MR. WALLICH. Well, another of these suggestions does appeal to me a great deal and that is to have specific topics, maybe relating to these fundamental [issues] that are listed here or maybe to how we [operate],

MR. PARTEE.

CHAIRMAN VOLCKER. The process should be covered in this
order, and we're not quite there yet.

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MR. MR.

WALLICH. Excuse me

MARTIN. I think there would be real merit from time to time in hearing a forecast presented by chief economists or some other staff person from one of the Federal Reserve Banks under the leadership of that Bank's president who obviously would be present and
participating in it. I realize that there are twelve Federal Reserve
Banks and four [such] meetings a year, but that surely could be worked
out if only by a lottery of some kind. I think it would be well to
have that kind of presentation. I don't know if it would necessarily
subsume or take the place of the staff presentation--the latter could
be in writing or some updates on the highlights could be expressed in
writing. I think we might benefit from hearing the point of view from
one of the Fed Banks from time to time.
MS. TEETERS. Well, there is a consensus in the forecasts out
there. Now, if you want a different point of view, you go to someone
like Mike Evans and I don't think that--

MR.

PARTEE. Or Gary Schilling.

MS. TEETERS. Even the private forecasters come in with some
semi-consensus. There are a few outliers in each one of these and
they generally tend to be the same persons.

MR. MARTIN. This is a System comprised of a Board and twelve Banks, and I think from time to time the Banks should be heard from in that context and in that forum.

MR. RICE. That's a very good suggestion. We never hear what the Banks forecast. We don't know what they have. All we know is what the Presidents say. MR. ROBERTS. You're quite right. We put our forecasts in writing for the purpose of the midyear report. We put our GNP estimates in writing.
MR.

RICE. And who sees them?

CHAIRMAN VOLCKER. They're for everybody. They're not always
comprehensible.

MR. RICE.

More often than once every six months?

MR. ROBERTS. I think the frequent staff updates are very useful. They permit me to compare with my internal research staff estimates and help prepare me for these meetings. I would prefer to see it kept on that basis rather than move to quarterly.

M R . PARTEE. I would have thought, Emmett, that if a Reserve Bank had a significantly different forecast, that would be highlighted by the President in making his or her comments. I've often heard a

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President say "Well, ours is a little different." And maybe that
could be amplified more when there is a difference. I assume that
every Reserve Bank is making a forecast also.
SPEAKER ( ? )
MR. MR. MR.

. Sure

ROBERTS. And getting the input of private forecasters. RICE. But we don't know what they are. PARTEE. We don't care unless they're different.

M R . RICE. It might be useful some time just to hear the forecast if a Bank has one that is markedly different. I think it would be of interest.
MR. GRAMLEY. If what we want to do is learn what the Banks are forecasting, then we ought to assemble a series of forecasts and put more numbers on the table rather than less. It just seems to me that we're talking at cross purposes here: On the one hand about not having so many quantitative forecasts on the table and not so frequently, and on the other hand about putting some more on the table. I'm not sure what we're trying to achieve with this.

MR. RICE. No. I think what Preston was suggesting was that in the "off" meeting--that is, in a meeting when we're not looking at a quarterly forecast--thatperhaps we could look at a Bank forecast or maybe even an outside forecast instead.

M R . WALLICH. Well, I think we're moving in the direction of the Blue Chip [summary of forecasts]. We have a survey of all forecasts, which incidentally I think is updated every four weeks or every month for the most part. And I think there's some merit in seeing how the central tendency moves.

CHAIRMAN VOLCKER. I'm not sure myself that there's much merit in seeing how the central tendency moves. It's usually wrong. But occasionally somebody will have an insight--alittle different way of looking at things--thatmight be useful to take into account.

MR. MARTIN. A different insight and the reasoning that goes behind a forecast that differs from the staff's forecast-­

CHAIRMAN VOLCKER. I'm not interested in seeing more
forecasts that look just like the staff's forecast.

MR. PARTEE. Well, the trouble is that some things are insights and some things are just poor forecasts.

CHAIRMAN VOLCKER.

It's your job to tell the difference.

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M R . WALLICH. Well, in that case, wouldn't it be a function of looking at a range of forecasts and selecting some that seem to differ in an interesting way for reasons one can understand--because they have a different view of how the economy functions, or have a monetarist or other view--and then focus on one such forecast. But it would have to be pretty selective. One couldn't just say at each FOMC meeting another Federal Reserve Bank-­

CHAIRMAN VOLCKER. I think what you're suggesting is more
what I had in mind. But you wouldn't routinize it; you couldn't.
VICE CHAIRMAN SOLOMON. We'd need a supply side President!

MR.

PARTEE. A gold standard President--thewhole variety!

MR. MORRIS. Could we leave it that if a ReSeIve Bank has a fundamentally different point of view--and that's going to be very rare--that that:point of view might be put on the agenda? I think very often the difference between my staff and the Board staff is that
the Board staff is constrained to assume that the rate of growth of M2
is going to be at the midpoint of its range and my staff says it's not
going to be at the midpoint but, say, toward the upper end of the
range and, thezefore, they're talking about larger nominal GNP growth
next year. If they had the same assumptions, they probably would come
up with the same numbers. But the Board staff does operate under
certain institutional constraints, and maybe those constraints ought
to be examined. Or maybe we ought to give the staff a little more
help on what the most probable outcome will be.
MR. PARTEE. Then you want the staff to give a forecast not associated with the Committee's policy? MR. FORD. No, but it should be associated with the Committee's average pst deviation from policy. MR. MORRIS. In recent years the FOMC's target more typically has been the top of the range than the midpoint. It seems to me-­

CHAIRMAN VOLCKER. I don't think the staff always takes the
midpoint. Do you? I have no faith that they can tell the difference
between the midpoint and the upper end.

MR. KICHLINE. Generally, though not always. But we have tried to follow what we would read the Committee-­

CHAIRMAN VOLCKER. Yes, if the Committee said it expected
growth to be in the upper half, you would have taken something in the
upper half.

MR. KICHLINE. That's right. But, even so, I think the point President Morris is making is that what we are doing--orlike to think that we are--isconditional forecasting. We try to specify certain

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[assumptions] on the fiscal and monetary policy sides, always, but
there may be other things as well.
MS. TEETERS. Well, occasionally, such as in February, you
provide alternative forecasts, given different assumptions. Maybe
that is the sort of thing we need more than we need outsiders--and I'm
not putting the Banks with the outsiders. Maybe we need a bit more
nmning of the alternative interest and money assumptions as to what
difference that would make in terms of the forecast.

MR. AXILROD. Well, we do that twice a year, Governor Teeters, in conjunction with giving alternatives for the long-run targets. I must say that half the time--I've thought of working up my courage to admit this--becausewe work off the model all it conveys is that if we have a little more money [growth] we're going to have more
GNP now and more prices later. There's really nothing else that comes
out of there. It's a bit mechanical.

CHAIRMAN VOLCKER. That's one thing I don't need a staff for,
because I look at these things often enough to give me a central
forecast without any help.

M R . BOEHNE. I think we basically have a good process here, and it seems to me that very few if anybody else in the economic policymaking business or even in the private sector has an economic intelligence-gatheringmechanism such as we do. I think it's really
rather good, and we ought to be careful in tinkering with it. What I
think I hear you saying, Mr. Chairman, is that you would like to have
some differences of views, some differences of opinion. It seems to
me that that can be had by encouraging that type o f activity where there are legitimate points of view rather than trying to change the basic mechanism that we have. So, where I come out is that we stay about where we are but encourage members of the Committee to come forward with different points of view. From time to time it might well be worthwhile to have a separate more formal invitation, but I would not want it to become a mechanical thing--that the mid-meeting of the quarter is the time for a different point of view. There are
times when there are different points of view and it takes some effort
to search those out, and I think we ought to hear those points of
view. But I'd keep the system basically as it is with a new alertness
to opportunities to bring different points of view to the table.

CHAIRMAN VOLCKER. Are you all feeling alert? It's not so
easy, I'll tell you. Well, we'll continue to ponder on this. Let me
go to "2.a,"the topic that Henry Wallich alluded to. This is just a
question of occasionally--maybeonce a quarter or whatever, probably
when we are meeting on Monday as well as Tuesday, which we do
occasionally anyway--focusingon some particular aspect of interest to
policy or the outlook that may be a bit removed from the monetary
policy directive.

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VICE CHAIRMAN SOLOMON. Some of these “copicsl don‘t have too
much bearing--for example, the productivity discussion, probably--in
terms of factoring them into monetary policy in a direct way. But one
can think of topics that would have a [more direct1 impact. One is
certainly the deregulation, which those of you in Washington are
closer to, expected next year and the year after. The Iimplicationsl
of that would have a closer correlation with the monetary aggregates
and changing banking practices, et cetera. And then there are issues
that have an intellectual interest in and of themselves, even though
they don’t have that close a relationship It0 monetary policyl. I
have felt all along that we never have had a really good discussion of
the stimulative effects of large fiscal deficits as against the
interest rate effects, and there are different time lags in that. The
doors are open for [unintelligible1 need discussion.

MR. KEEHN. I‘d certainly agree with that. I think there are some very interesting and important economic structural ideas that may not be directly related to monetary policy but certainly create the environment in which we’re making decisions. It‘s conceivable that we’d have 2 or 3 parts to a presentation that would represent different points of view on an important issue, but I think it would be extremely interesting and very important.
MR. GRAMLEY. Is there anything that we can get from a briefing of that kind that we couldn’t get in a document? What we ought to focus on is whether or not this particular group is one in which a group discussion of a subject of this kind is more conducive to learning and the advance of knowledge than getting a detailed staff
document presented to us ahead of time. It’s hard to discuss
productivity trends; it‘s a very technical subject. I‘m just not sure
you can sit down with a group like this and discuss productivity
trends with much benefit, as opposed to our having a staff study done
on productivity trends and reading it ahead of time.
MR. KEEHN. Well, Lyle, 1’11 bet there are some people in the productivity area who can give a presentation that will provide a level of knowledge from which I can then read a staff study that would have a lot more meaning. Some of these studies lend themselves to a presentation [that would lead to1 understanding a bit more easily than perhaps a very thick staff study.

MR. CORRIGAN. Well, I’m not sure on the productivity issue, but on the kinds of things that Tony mentioned, analytical and otherwise, such as issues surrounding deficits, banking structure, and deregulation or the implications of financial phenomena on the international side, I personally think that some collective discussion could be extremely useful.
MR. MARTIN. Well, I think a point can be put to certain kinds of discussion of that sort. Let me pick up on Jerry’s comment about the international debt situation. After a presentation and perhaps a paper ahead of time. which would focus our attention again

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only more so on a subject of that sort, we could move toward a "what if" mode of discussion. That is to say, we'd discuss what would be the monetary policy implications and the recommendations that might flow out of a series of events. The "what if" technique is one that most private corporations use when there are major series of events that would affect the future of the organization. And we might profit
by some preliminary thinking, without any commitments or votes or
anything else, as to what our policy recommendation would be if a
certain series of events occurred.

MR.

WALLICH. It's a sort of contingency planning

VICE CHAIRMAN SOLOMON. Or it has implications for monetary
policy, too, using Preston's example of international--

M R . WAZLICH. Well, it seems to me the question that Lyle raises--thatwe might just as well read a paper--canperhaps be met by relating this more specifically to monetary policy. And there, the members of the group could provide their input. Suppose you postulate that something happens to price stability, to the financial structure, or to fiscal output and ask: How should we respond?

MR. GLTFFEY. Mr. Chairman, I'll agree that this has some attractiveness, but I wonder whether or not the forum of a Monday afternoon meeting such as this is the proper place to have assigned a topic and have a presentation made after we have received a paper that might identify 3 or 4 of the issues that we're talking about--fiscal policy and the deficit being one relating to monetary policy. We could actually do something, as we did in Fredericksburg about four years ago now, such as devoting a day or a day and a half or two days
to, say, as many as four topics, all of which are interrelated. And
we could focus this group's attention on the matters that affect
monetary management in the period ahead. I think to do it piecemeal
Monday afternoons before a Tuesday meeting over a period of a year,
just as an ongoing program, might not be quite as effective because we
won't connect them with what we're all about.

CHAIRMAN VOLCKER.

Any other comments or reactions?

M R . WALLICH. Well, I think we might occasionally focus not on what we're going to do but on what we have done--doa sort of post mortem and ask ourselves how we would do it differently if we'd known what was going to happen, and maybe evaluate our own performance that way. I don't mean the staff's performance on the forecast; I mean our performance in making monetary policy decisions.

VICE CHAIRMAN SOLOMON. Did we bring down the rate of
inflation by reducing the growth of the money supply or by having an
intense recession? Hindsight might prove interesting.

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M R . WALLICH. We could certainly debate that. Did we do it too fast? Did we do too little? Could we have done it some other way?
MR.

MARTIN.

I take it these sessions would not be recorded?

MR. BALLES. I’d just like to add my voice to those who think that this would be a useful thing to do, whether it’s once a year or twice a year. whether we meet on a Monday or whether we do it in a special session, I think there certainly are plenty of subjects that
we could quite profitably take up at such meetings and get away from
the standardized format of these meetings. Otherwise we focus on the
near-term outlook except twice a year, in February and July, when we
take a look down the road. I’ve had some sense of frustration, for
example, just in the last month on what seems to be the unclarified
differences of views between the Board‘s staff and my staff on whether
or not there has been a basic shift in the elasticities of M1--
something that gets right to the heart of what we‘re trying to deal
with here. what does the evidence really show? We happen to have
done quite recently a major study on this--it is circulating and we
would like some reaction to it--which [suggests] that the elasticities
of M1 have held up amazingly well, with very little change throughout
the ’70s and right up to mid-1983, despite the introduction of all
different kinds of accounts paying rates more and more related to
market rates, going back to the days when corporate savings accounts
were permitted, etc. And that certainly is at distinct odds with the
view that I think prevails among the staff here that has led to considerable skepticism as to whether we could get back in the foreseeable future toward reinstituting M1 as a key target.

Now, this is the kind of thing that one cannot absorb in 5
minutes of quick conversation. And it’s hopeless to try to get both
sides of that argument presented in the course of one of these
meetings. That is a subject that I think is extremely close and
important to the decisions we’re making on what kinds of targets and
what ranges [to adopt]. That would lend itself to a presentation in
depth. You name it: Two of our senior staff members who don’t agree
could present the evidence and try to get on the table some of these disagreements on interpretation and analysis of what history shows. Let’s take a good hard look at both sides and try to make up our minds and get off dead center on this issue. That‘s the kind of subject I would like to add to the list of possible special topics, Paul. CHAIRMAN VOLCKER. Any other comments? The only reaction I
have to Roger’s comments is that it would take a lot of work to do any
of these things, and to have a big meeting once a year would take one
heck of a lot of work concentrated in one--

MR. GUFFEY. A great deal of preparation work could be done within the Federal Reserve Banks as opposed to the staff here. But perhaps you’re referring to the logistics of getting some place.

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CHAIRMAN VOLCKER. No. I was thinking of the whole process.
what we did at Fredericksburg took months and months to-­
VICE CHAIRMAN SOLOMON. I would prefer to start off with
having one issue discussed on a Monday afternoon and see how that
goes, Roger. I think the other more full-blownexercise suffers from
too many inputs.

MR. GUFFEY. There are about four or five issues in my mind at the moment that all interrelate and are important to one's individual view of how policy [decisions] should be made in the period ahead--whichwill be a difficult period--andthat I think should all be discussed together with a summary at the end. That's the reason
I'm really suggesting one session with an in-depth discussion--more
than a Monday afternoon.

CHAIRMAN VOLCKER. Well, let me turn to one part of this,
which I m not sure quite captures [entirely] the flavor of what I have
' in mind--I'm not sure that anything can. One way of approaching it is
the way John Balles touched upon--just to look at it in a very narrow
focus. Now, there is a good chance that the Humphrey-Hawkins Act will
be rewritten, probably not to take out monetary targeting entirely but
to put it in a subsidiary role. Is that a good idea or a bad idea?
It's not entirely under our control, to say the least. But it gets
into the broader question of whether or not the Federal Reserve tells
the country what its objectives are. We can answer that on one level
by saying our objective is that M1 should be 5 to 9 percent, M2 should
be whatever it is, etc. But then it gets eventually into the
questions of: What unemployment rate are you satisfied with? Or what
price level are you satisfied with? That, in turn, gets into the
question of whether the Federal Reserve should be considering that or
whether the U.S. Congress or the President should be considering that.
All these questions come at us fairly continuously. And if interest
rates go up or if the economy stumbles in the next few months, they
will come at us with extreme vigor. If things go smoothly in the next
few months, they probably won't come at us for six months but they
won't be gone very long. How do we respond to this question? what is
our ultimate objective as a central bank? Let me just leave it right
there. I'll start it in its most general [forml.

It does seem to me, Mr. Chairman, that we should start doing some thinking about this--againthis is in the nature of contingency planning--ifwe're forced into nominal GNP targeting. I think that has a lot of problems associated with it. How should we try to shape it?
M R . MORRIS.

CHAIRMAN VOLCKER. Well, let me just be a little more specific on that. I would think the chances are at least 75 to 80 percent that we will be forced to give more GNP projections over a longer period of time. It's just a question of what leverage we have now to shape, as you say, what we should say we're doing.

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VICE CHAIRMAN SOLOMON. When we give those projections we
would have to say, assuming that fiscal policy does X, Y, Z, and
assuming that-­
CHAIRMAN VOLCKER. Well, it gets to this question: Does
fiscal policy make any difference at the extreme? And what do we say
about it? That's another aspect of this. What are our goals [in
relation to3 the Congress? [Suppose Congress said:] "Let's have a
summit session to resolve this and we'll make a change in fiscal
policy." How would we change monetary policy? How would we respond
to that?

MR. BALLES. Well, Paul, I'd like first to refer to your two pieces of recent testimony before the House and Senate Banking Committees on this general subject of adding new objectives or being more specific on the GNP or the interest rates forecast or whatever.
First of all, I'd like to congratulate you on what I thought were two
excellent statements that tried to head off simplistic interpretations
by anybody in the Congress or overcoming the idea that somehow all we
have to do is press buttons around here and we can come up with some
sort of interest rate result or GNP result. I think all the proper
cautions certainly were embedded in your testimony. There is one
point on which I personally would have gone a little farther, or
perhaps differed a bit in trying to respond to the kinds of challenges
that were thrown at you. And, of course, this is a view with which
everybody around the table might not agree. But I would have felt
forced to discuss the fact that, at least in my view, in the long run
the principal effect that monetary policy is going to have is on the
price level. And that in the long run the principal effect that
fiscal policy is going to have is on the real side of the economy--on growth, productivity, the rate of wage increases, personal income, and so on. Looked at in that framework, I think there's a very good theoretical structure to support those other end result conclusions. We have a good reason for denying that the Fed can or should be given any specific responsibilities for bringing about given end results on GNP, whether real or nominal.

CHAIRMAN VOLCKER. Let me explore the implications of that. I think you raised the basic issue. Now, suppose the resolution is passed saying that we must give forecasts on nominal GNP, real GNP, and prices 5 years ahead. Now, do we take Mr. Balles' view and say the price level is the only thing we're really affecting over the long run--that's the long run by definition, the fifth year--sowe're just going to project zero inflation 5 years from now?
MR. MORRIS. I don't think that is very relevant to the Committee, Mr. Chairman.

MR. BALLES. It would be a little extreme to take that position, obviously.

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CHAIRMAN VOLCKER. Well, I'm just exploring the logic of what
you just said.

MR. BALLES. Let me explore it one step further. What I would do if I were in your position, is to say: "All right, if you want our view on what is likely to be the result 5 years down the road, here are the assumptions I'm going to make about what you people in the Congress are going to do with respect to the federal budget on the spending and the revenue sides and the resultant deficits. Given
those assumptions, this is not something that we at the Fed can do a
d a m thing about." I would keep hammering that one.

CHAIRMAN VOLCKER. No, they'll permit us to say that.

MR. BALLES. But here is what the likely results will be in terms of real income, real GNP, the unemployment rate, inflation, and so on.

CHAIRMAN VOLCKER. What are you going to put down for prices?

MR. GUFFEY. I'd like to comment, Mr. Chairman. I happen to agree with John in the sense that in the long run--whether it be 5 years or whatever horizon you want to select--pricesare the only thing that a central bank should or can control. So, if Congress wants to change the legislation, then it should be stated specifically that our objective is to bring down inflation to zero over this long x u n and maintain it at a stable level of zero. But that doesn't, I think, respond to the shorter run in that we have to make some announcements on a year-to-yearbasis. And it seems to me that the greatest flexibility that quite likely can be achieved for the Federal Reserve is to do its job by looking at a nominal GNP forecast or, if
you will, objective. It's unclear to me whether it's an objective or
a target or whatever. But to stay away from the real variables and get into the nominal variables [using] nominal GNP is the only way we can truly operate. And in that sense, we can have a subset of prices and real GNP in the short run and even a projection; I guess we could be pressed to the wall on what that means for employment. But it gives us the flexibility to say that if our overall objective is to move inflation to zero over this longer horizon, then it does have
some implication for the kind of policies that affect real output,
such as fiscal policy and all the other things. To go any further
than that seems to me risky.

CHAIRMAN VOLCKER. A whole series of questions arise here. But suppose we get asked--1was asked or volunteered last time, though it didn't go very far. Suppose Congress is rewriting the Federal Reserve Act, not just the Humphrey-HawkinsAct--though it doesn't make any difference what legal guide it is in--andwe are asked to rewrite the charter for the Federal Reserve. In 25 words or less, what is our objective? What do we say to that?
MR. BALLES.

A zero rate of inflation in the long run.

-14-

MR.

GUFFEY. That’s right.

MS. TEETERS. Mr. Chairman, I happen to disagree with this
idea that all we are affecting is prices. I think we affect both real
output and prices. And I think we--

MR.

GUFFEY. In the short run

MS. TEETERS. And the long run too, because I think long-run

levels of interest rates determine a lot of things in the economy--how
much [growth] we’re going to have or not have. I see our function as
doing a balancing act between how much we let prices rise relative to
the cost in terms of increased real GNP or how much we depress real
GNP in order to lower [inflation].
Now, these five-year forecasts are pure unadulterated cop-
outs. First of all, we can‘t project that far out; and the work we’ve
done here shows that the error in our ability to achieve [the
forecasts] increases dramatically beyond about 18 months. It’s like
the official forecasts that the government does on where the budget is
going to be. If you ever look at them, the budget is always balanced
in the fifth year; and it never happens. So, what you‘ve done is to
take a short-term forecast and [assumel average rates of growth and
you do everything you can to get whatever objective you want to come
out with. And I don‘t see that they have any relevance whatsoever
because they never occur. If you look at DRI’s long-range forecast,
it is an average rate of growth after 18 months and they put in the
average length of the business cycle since the end of World War 11.
That’s all they are. We really don’t have much more capability beyond
that. Another way of coping with this, which might be very
interesting, would be to do GNP forecasts once a month instead of
twice a year and publish them because then we would convey more of the
uncertainty about our ability to do this and how much the GNP
[outlook1 changes and how much our idea of what we’re going to do
changes. So, increasing the frequency [of our forecasts] and
[showing] the frequency of the changes in it gets away from the idea
that we can control the whole world, which is the view they have up
there, I think.

M R . MARTIN. Would you publish the forecast or the [unintelligible1?

MS. TEETERS. Sure.

MR. GUFFEY. I’d like to suggest that what I‘ve just laid on the table is not a forecast. It is an objective stated in the law. It probably would require an amendment or deletion from the Full Employment Act of 1946, which gives us stated objectives of full
employment and stable prices. Those are inconsistent in my mind. We
speak of the trade-offs in balancing discretionary policies and I
agree that that must take place in the short run. But if our overall objective is to move to zero [inflation] over some time horizon and

-15-

maintain it, then we move to the other, and I ' m suggesting nominal
GNP .

MS. TEETERS.

No. it's just by getting out of the situation.

CHAIRMAN VOLCKER. Well, let me raise this question just in
curiosity. How many people would think our objective ought to be zero
inflation--thinkingwhatever is in your mind as to what that implies-­
over something that I will conveniently call the long run, which is between 5 to 10 years? SPEAKER(?) . Mr. Chairman?

CHAIRMAN VOLCKER. Regardless of whatever else goes on now,
that's our objective.

MR. WALLICH. That's a precondition for succeeding in anything else.

M R . FORD.

That is measured by what: the CPI? May we talk or are we just voting?

MR. BOEHNE.

CHAIRMAN VOLCKER. Well, you're just voting at this stage and
then we will talk. But I haven't expressed the question right. I
mean a zero on the wholesale price index and very close to that on the
CPI .
MS. TEETERS. Regardless of what it costs?

MR.

PARTEE. Regardless of the-­

CHAIRMAN VOLCKER. One can't quite say regardless, but that
that is our [unintelligible1 objective, and that basically we think
everybody else is going to be responsible for everything else.
objective.
MR. GUFFEY.

I don't think a central bank can handle that

CHAIRMAN VOLCKER. Let me just get a showing of hands now . . . . There's a great discrepancy between [those in] Washington and the rest of the country.
MR. BOEHNE. Well, I'm in the rest of the country and my hand is not up. I have some problems with it. I think this notion of the long run is somewhat equivalent to the mathematician's notion of infinity. It's a nice theoretical concept, but does not have a whole lot of relevance to the real world that we live in. It seems to me that we are always living in a series of short runs and we never get to the long run. In a theoretical concept, sure, at some point out there that we never reach we could have zero inflation or 2 or 3 percent [to allow] for quality improvements and frictional

-16-

unemployment. But the fact is that we never get there. We're always
banging the pendulum back toward the middle. If it gets too far one
way, we bang it. It just seems to me that it's totally unrealistic to
think of monetary policy in the economist's view of the long run
because we never get there. So, my hand didn't go up because I think
it's a nice concept in a textbook or in a model, but it just doesn't
bear very much resemblance to the world that I live in and that I
think everybody else lives in.
CHAIRMAN VOLCKER. Mr. Ford.

MR. FORD. I'm trying to remember what my math professor taught me abouc the relevance of the concept of infinity and I'd just like to part company with Ed starting there. W e n in mathematics infinity is a relevant concept, especially in space calculations. I would say that we should shoot for a zero [inflation rate1 properly
measured over a period of time. And if we are going to be pressed to
say something about GNP, as we clearly are, if I had to face the fire
right now, I'd be inclined to go for a nominal G ' goal on the grounds
NP that over time it's the duty of the central bank to provide sufficient
money to allow the economy to expand at whatever we could agree is its natural rate, without inflation, whether we're talking about the short run or the long run. Even in the short run, I think it's very relevant. 1'11 bet you that when we get around to tomorrow morning a lot of people are going to reflect on the fact that tnominall GNP grew 13 percent in the second quarter and real GNP supposedly grew 9 percent. Over time that just is not sustainable. The economy is surging. And if we had a long-run nominal growth target that said we don't want nominal GNP to expand in the double-digit range ever, even coming out of a serious recession--I'd be willing to throw that on the table just for discussion--. We might allow some variation, but why should it ever be double-digit when we know the natural growth rate of the economy over time is somewhere between 2 and 4 percent? So, if you're pressed, I would say that your retreat position ought to be to
talk about nominal GNP and then continue to keep the pressure on
[Congress1 to recognize the fact that we only affect nominal variables
in the near term and perhaps in the long term as well.

MR. MORRIS. Mr. Chairman, the one thing I would suggest, if we're going to have a nominal GNP target, is that it ought to be a range rather than a point because I don't think we know enough to set a point as a target. For example, for the current year we are now projecting 10.7 percent nominal GNP growth. I think earlier in the year, if we had had a point target, we would probably have projected something like 9 percent. That was what I was thinking of at the time. Now, the question is: Does this mean that we should currently follow a much more restrictive policy in order to move [GNP growth1 back toward 9 percent? Given the fact that the inflation numbers have come in so well--probablybetter than we would have anticipated--in that kind of situation there's a little more room for real growth than there would have been in an economy in which the inflation numbers came in much worse than we expected. So, we'd be prepared to move

-17-

within that range depending on the mix between real and inflation that
makes up that nominal GNP gain. But we should never get stuck with a
point estimate on a nominal GNP target.

MR. WALLICH. I think the long-run concept is a helpful one because we have to find a way of differentiating ourselves. We want to have a special function where we’re not criticized by the Congress continually and compelled to coordinate. We‘ve got to be somehow
functionally different. And one reason for that could be that we take
a more long-run approach; a central bank traditionally does that,
compared to the people who have to face elections. We can also limit
ourselves to the nature of the objectives we’ll go for in determining
growth, determining unemployment, and so on. There’s never a resting
place; we can never get unemployment down low enough. And we should
surely never raise it deliberately because it’s falling below target.
So, I think sticking to the price objective in the long run is a fairly safe posture that will give us a chance to do our job.

CHAIRMAN VOLCKER. Mr. Roberts

MR. ROBERTS. I think Congress is pressing us toward a desirable goal. I believe that we tend to be too short run oriented. I would like to see us be long run oriented and accept objectives such as zero inflation. If we’re not standing for that, I don’t know who else is. And I think it’s desirable. I think often in our short-run
responses, which tend to be erratic as I review the past, we are
counterproductive and create perverse results. If we had a longer-
term perspective, we could stay in the right direction. So, I‘d like
to see us move that way.

CHAIRMAN VOLCKER. Just to explore the point: Does that mean
that if we had to make a 5-year forecast, you would just start out
with the presumption that in the fifth year inflation is zero?

MR. ROBERTS.

Sure. Why not?

It‘s an objective.

MR. MARTIN. Arguing the other side, I think the why not, Ted, is that we deal in a real world in which there are imperfections in the pricing process and the allocation of reserves process and the changing nature of foreign competition and its impact, much of which
is positive as far as prices are concerned. Given the present level
of unemployment and the difficulty of employing a segment of the
people who are in that very unfortunate category, over time if we were
indeed to bend our efforts to achieve zero CPI inflation, however
measured, we would have a resultant unemployment level that would be
destructive to the social fabric of this country.
M R . ROBERTS. Well, that might be true. I disagree with you entirely, however. I think the best rationer of resources in the economy is the free market. And I think the best way to compete internationally would be to have a zero inflation level. If we want

-18-

to subsidize sectors of the economy, we should do that explicitly and
let people recognize what they're going to pay for it.

M R . MARTIN. But the subsidies are built into our society. Those subsidies are not going to be taken away. Those imperfections are not going to vanish. The government impact in the allocation of resources is a constant; it is a parameter. We have an imperfect world; we can't have a perfect price level in an imperfect world.

MR. ROBERTS.

Different point of view. Mr. Boykin.

CHAIRMAN VOLCKGR.

MR. BOYKIN. Well, having a zero rate of inflation as the objective, at least as I construe the objective, does tend to be [in the realm of the1 theoretical. On the other hand, if we don't keep that at the forefront of our thinking in the policy decisions that are
made in the short run, it seems to me we lose a lot of the discipline
that's necessary to keep inflation at least at a relatively low level.
And I do think that low inflation has to be the most important factor
in sustaining real economic growth over time. Now, that's not to say
that in the short run we don't have to take account of the real world.
But the danger I see is that in the concern with the immediate one
loses sight of the longer-run objective. If that is stated as the
objective, using the five years gives room for adjusting a little in
the short run. But it brings the discipline. If we set a 3 to 4 or 5 percent rate of inflation as the objective, it's going to turn out to be 10 or 15 percent.
MR.

MARTIN.

[Multiply] by two.

M R . BOYKIN. I just don't believe that. If you look at what has happened, going back to October of 1979, the one thing that we have done is to bring down the rate of inflation. Now, you can argue about what the cost has been. The cost has been very significant. But is that cost excessive in terms of what the costs would have been otherwise?
MR. MARTIN. I don't think the choice is between zero and infinity. I think the choice is between zero and some rate that's less than, let's say, the average rate of the last couple of years. MR. WALLICH. Well, one has to realize that the goal is not going to be achieved. As an objective, it gives us a place to stand. Now, when we begin, if we only reach 2 percent inflation and we had aimed at zero, I fully agree that I would be quite satisfied. But if we started with 2 percent, somebody else would outbid us with 4 percent because that would get a little more growth, and pretty soon we would be at 14 percent. So, we might as well start with a clear objective. I'm not saying this is something that will be reached.

-19-

MR. MARTIN. My clear objective is 2 percent because I think it would result in enough employment that it would be a more realistic objective.
MR. PARTEE. I would feel that it could be 2 percent or it could be zero. But the most important thing is to make sure it's ' always 5 years away, like the long run! You know, I m speaking halfway seriously. Assuming that the economy is dynamic, we could always say that whatever unsatisfactory result we had, we ought to plan to get rid of it over a reasonable period of time. And that
could be, say, 5 years, although there might be some other number of
years that would be analytically better. And then we'd try to develop
a policy to get rid of [that unsatisfactory result]. And it makes a
lot of difference to say we have as an objective a zero rate of
inflation in 1988 or to say we are shooting toward a reduction in
inflation to zero over the next five years. [In the latter case1 then
next year it would be five years, and the year after that it would be
five years and one would always then maximize the choice that could be
made to get the best combination of output and structural and price
results within that kind of [tradeoffl.

MR. RICE.

Would you be willing to specify a rate of growth

at the same time?
MR.

PARTEE. Yes, I think one can do that

M R . RICE. Say, a rate of growth consistent with the long-run growth potential of the economy, whatever that is?
MR. PARTEE. Well, [growth] ought to be more than that between now and 5 years from now because we're well below the optimal use of the economy now. MR. RICE. I would have no problem if you people were willing to state what you consider to be a maximum rate of growth along with a zero rate of inflation five years out. MR. PARTEE. We could always determine this equation pretty easily. That's a-­

VICE CHAIRMAN SOLOMON. So our report card in five years
would show we failed on both.

MR. PARTEE.
MR.

It would necessarily do that, I think

RICE. Exactly.

VICE CHAIRMAN SOLOMON. I don't really understand--wedo live
in a political world--why you believe that it's perfectly appropriate
to have objectives that we fail on and never reach.
CHAIRMAN VOLCKER. I don't understand that either

-20-

MR.

PARTEE. That's an analytic--

M R . ROBERTS. That's a common approach in other enterprises, where people say: "I have an objective and I either meet it or I don't." There are variances and they are either controllable or they are not. We could go back, for example, to Congress if our inability to meet that objective was due to something they did and say: "Here are some reasons why we couldn't accomplish this." And that might be good public policy. MR. BOEHNE.

Like a 10 percent unemployment rate

MR. RICE. Yes, we'll get a D-. Mr. Chairman, getting back to the strategy question you raised, if you see a 75 percent chance of there being some legislation requiring us to state specific objectives in numerical terms, I suppose the question is: What sort of compromises would you want to work out?

CHAIRMAN VOLCKER. If we get this legislation, I might say
we'll be sitting around here arguing about precisely this: What do we
put down for a number 5 years from now?
RICE. The question I'd like to raise is: Are we better off trying to find some way of accommodating to this or should we oppose it and try to resist it as long as we can until it actually [becomesl the law? I would favor trying to stonewall it to the very
end. If they're going to pass some kind of legislation that's
difficult [for us], I myself wouldn't want to offer them any help.

MR.

CHAIRMAN VOLCKER. Well, just in terms of where we are, I guess I have in effect conceded that if they don't state it as an objective for some kind of vague assumption for 5 years, we'll provide them with some 5-year numbers in a range.
MR.

RICE. Well, then will we come back to the-­

CHAIRMAN VOLCKER. But we won't state them as an objective.
That's where we now stand.

MR. FORD.
MR.

Based on?

RICE. What do we call them if they're not objectives?

CHAIRMAN VOLCKER. Assumptions, projections, forecasts

MR.

RICE.

Projections with or without a given policy?

CHAIRMAN VOLCKER. Well, we get back to the fiscal side,
which is the main alternative. The last time we discussed this, you
told me fiscal policy didn't make any difference--notyou; I'm
speaking of "you" collectively. Governor Gramley.

-21-

MR. GRAMLEY. I want to say a couple of things first about the abstract proposition and how to implement it. I would start out agreeing with the long-run proposition that we ought to focus primarily [on prices]; theory suggests that what happens to the money
stock primarily affects prices and not output. But I think that the
I don't think it's irrelevant--is50 years, not 5. But
long ---and it may have the following kind of relevance: We always ought.tobe
very careful, whatever we do, to make sure that we focus enough
attention on what our policies are going to do to prices over a long
period.

Let's try to put this in the context of the decisions we've
been facing as a Committee in recent months. I don't know of any
forecast that projects a continuing substantial decline in the rate of
inflation beyond the middle of 1984. And, if we were so single­ mindedly in pursuit of a zero rate of inflation, I don't think we would ever have turned around in the middle of 1982 and provided for the kind of environment that has encouraged the recovery in the economy. We would have single-mindedly kept going in trying to bring down the rate of inflation. I just don't think we can do that; I don't think we can have any specific objective for a rate of inflation 5 years from now without putting it in a context of what is happening to the economy now and what is feasible over the next 5 years. VICE CHAIRMAN SOLOMON. I agree with that 100 percent. There is nobody in this world--certainlynot in the financial community--who believes that the rate of inflation, which is presently around 4 percent, let's say, is going to be 3 or 3-1/2 or 2 percent over the next 3 or 4 years. All the assumptions are somewhere in the 5 to 6 percent range, and yet people assume that we are making a very sincere effort. I just don't see that as being realistic at all. I come back, I suppose, to the other aspect. I don't think that it's credible or even that it would be accepted. We'd be laughed at if we said our only legitimate objective is price stability because we all admit that in the short run there is a tradeoff. Nobody is going to believe, based on some kind of [abstract] theory that there's no
employment impact as we pursue our objectives over a 5-year period.
People just won't understand that kind of assertion. I don't think we
can get away with it, and I m not sure it's even right. I think it's
' more credible to take the line that the Chairman did in his testimony,
which says we don't have control of all these factors. I'd hammer
away at that as long as we can rather than take the [position1 that over 5 years we have this one objective that tCongress1 should charge us with, which is price stability. Over the long run we can have any
level of unemployment with price stability as well as we can have any
level of unemployment with varying levels of inflation. Sure, it's a
sound theoretical proposition, but I don't think it's a credible one.
I don't know what we should do. If I were asked to give forecasts,
assuming they come off this objective business--you've given that
away, I guess--then I think I would have to say the forecasts are
subject to certain assumptions, such as what is happening to fiscal
policy, what is going on in wage negotiations in the country, and a

-22-

few other factors. I would never give an unadulterated, unconditional
forecast or assumption for the next five years.

MR. BALLES. I'd like to come back and deal with this matter of the short run versus the long run for a few more minutes. Even for those who are of the point of view that we're always in a series of short runs and we never get to the long run, I would add the following caution: Sure, you can say that in the short run there's a tradeoff between inflation and unemployment; I think there's a lot of history
in this country, including the history of the last decade for example,
that shows that it's very dubious whether that tradeoff can or should
be exploited at least by us in the central bank, because the cost of
trying to take advantage of that tradeoff may well be a procyclical
monetary policy and a continuation of a business cycle ad infiniturn,
for reasons that I think can be pretty well elicited from a study of
what has gone on in the last 10 years in this country. If we start
with an expansion of monetary policy, trying to take advantage of this
tradeoff, sure, we can pump up aggregate demand; and nominal GNP will
rise and so will real output, and unemployment will go down and for a while nothing will happen on the inflation front. But, sooner or later, because these lags between money and prices are long, we do get rising inflation. Then we feel we have to pull in our horns and be more restrictive. And when we have tried to do that, I challenge any
one of you to show me when in the last 10 or 12 years we have ever had
a soft landing. When we moved to a posture of restraint because
inflation was thought to be a big problem, what happened? We had a
recession in the early 1970s; we had a recession in the mid-1970s; we
had a big fat recession in 1981-82--infact, some [observers1 take it clear back to 1980. Every time we finally have to adopt a posture of restraint because inflation is getting too strong, then we take [the cost1 in real output, in a rising unemployment rate, and so forth. That's exactly what has gone on in this country for the last couple of years. You can say, yes, in the short run there's a tradeoff. ?md I say to you that's a time bomb, and if you try to exploit that very
far, you'll just guarantee a repetition of business cycles and the old
boom and bust phenomenon.

CHAIRMPN VOLCKER. M r . Guffey.
MR. GUFFEY. Well, I'd just like to respond to Tony's comment earlier that a zero [inflation objective] is not credible. I'd make two points: One, I don't know how 5 years crept into this as being the horizon for the long term for moving prices to zero and maintaining stable prices [thereafter]. Maybe I inferred that. I donlt know what that horizon is, but it seems to me that a central bank of this country or any other country can have no other ultimate objective but to create price stability. What we have been operating under is a legislative directive that does require us to try to control things that are not within our control, such as full
employment. What I'm really suggesting is that what might be written
into this legislation, wiping out the earlier legislation, is that the
ultimate objective-- the single task of the central bank--is to reach

-23-

price stability over the longer run, whether it be 5 years or 50
years. I don't know what the [right] horizon is. Now, that does not
mean to suggest that there are not tradeoffs in the short run. That's
the reason I had suggested earlier focusing on nominal GNP, which
gives the Fed a little flexibility to operate and use discretionary
policies in the short run. That seems to me to be most appropriate.
To say that a long-range objective of a central bank is not to move to
price stability seems to me to run directly against the reason for a
central bank existing. I think it's just as basic as that.
VICE CHAIRMAN SOLOMON. Yes, I would agree that you can offer
that as a tautology, but I don't think that's really the issue here.

M R . GUFFEY. Well, I think it is. It's a starting place in my mind to get to what the Chairman asked: How is he to respond to the [Congressionall Committee and try to direct-­

VICE CHAIRMAN SOLOMON. Well, that's a first sentence. That's
like [saying] we're all patriotic Americans.

MR.

GUFFEY. Okay, let's not lose it, though. That's my

point.
M R . WALLICH. I think the zero inflation objective is in danger of getting a black eye because it's being misinterpreted. It doesn't mean that we say we're going to zero inflation in 1988 and if
we get to 1987 and have 6 percent inflation that we're going to do it
all in one year. It means we are moving in the direction of less
inflation so long as there is inflation, and we do that gradually. We
say we won't do it in 1 or 2 years but we will try to reduce the rate of inflation to zero over 5 years. That gives us a great deal of flexibility. We'll probably never get there and we should make it clear that [implementing1 this [objective] is subject to having a well working economy; it's not going to be done with 10 percent unemployment. It is giving a priority to this objective and stating [that it is1 a condition for the economy to be working well, because
in the long run we're not going to have much growth if we have high
and variable inflation and we're not going to have much productivity
and full employment. It's this more modest way that I'd like to see
the price stability objective stated rather than say we're going to
hit zero growth in the CPI in 1988.

CHAIRMAN VOLCKER. You leave me with a practical problem.
It's a little difficult to say all your nice words, which I happen to
agree with, and not put in zero for 1988 or 1989 or--

MR. MORRIS. I think the answer, Mr. Chairman, gets back to Nancy's idea, which I agree with. Certainly we all accept price stability as a long-run objective. When we get to the point of talking about nominal GNP objectives, I would agree with Nancy that we
can't go beyond two years; there are going to be many instances,
including this one, in which a zero inflation target is not feasible

-24-

within the two-year span. We can still accept that as a long-run
[objective], but the kinds of concerns the Congress has relate to much
shorter spans of time than 5 years.

MR. MARTIN. As soon as we express the zero inflation objective, however the time period is to be set or slipped, the first question the Chairman is going to receive, I believe, is: What level of unemployment does that entail?
MR. GRAMLEY. I think the question is not so much whether we have an inflation objective 5 years from now of 2 percent or zero or 5 percent or whatever, but if we take a sufficiently long period of time, like 5 years, our objective ought to be to move toward a lower rate of inflation than what is now prevailing. It's the direction of movement that's important, not any specific number we're going to get to later. I don't see why the idea of targeting on nominal GNP over a 5-year period is all that undesirable. It seems to me that if the
central bank'is supposed to work toward reducing the rate of
inflation, and if it's important to get the expectations of the public
working for us, then from the standpoint of national policy--notjust
monetary policy, but national policy more generally--the idea of
commmiting strongly to reducing the rate of growth of nominal GNP over
a period of time makes very good sense if we want to bring down
inflation.

VICE CHAIRMAN SOLOMON. Yes, but don't you have to give it
not just for the 5th year but for the 2nd, 3rd. and 4th years?

MR. GRAMLEY.

We may need ranges to do this.

VICE CHAIRMAN SOLOMON. In our discussions here we're all
assuming that at the very best inflation will be no higher next year
than 1/2 point higher than it is this year. Right? Now, how does one
accept that?

MR. ROBERTS. W o would have thought it would be 3-1/2 h percent in the second quarter?

VICE CHAIRMAN SOLOMON. No, he's saying that it should show a
progression of reductions.

MR. GRAMLEY.

I could fit that into a range.

MR. BOEHNE. Can't we express this uncertainty with some fairly broad ranges? Just taking some examples: Suppose we have a five-year target for inflation of 0 to 5 percent and we have a target for unemployment of 4 to 7 percent. I'm not wedded to those numbers,
but suppose we have a range--atolerance range--thatwe think might be
realistic. It has the concept of uncertainty and the concept of the
tradeoff in the short run, yet we haven't really betrayed a kind of
long-run idealism.

-25-

M R . PARTEE. Somehow we have to make adjustments for the failures that will occur--thecrop failure that may occur sometime in the next 5 years, maybe currently, or the OPEC oil price increase that may take place, or the really miserable fiscal policy that may materialize, if it hasn't already--failuresthat will give us reversals. That's why I said I really think [what is needed1 is a
moving 5-year average to get us into a policy planning mode that will
let us always be working at getting the rate of inflation down, but
not by a step-by-stepprogression over 5 years. The thing we have to look at relative to the year when inflation was 10 percent is that something happened over which we didn't have any control. But once that occurs, then we have to be working down toward zero again--zero is probably too low--butto a modest rate of inflation of the kind that could be [consistent with1 quality [improvement1 factors.

MS. HORN. I agree basically with what Lyle said and what a
number of other people have said that in the long run we're aiming for
zero inflation or price stability, and that might be a little greater
than zero. But isn't the way to get there a decreased level of
nominal GNP as time passes? a d , yes, we're going to have to make
adjustments, but don't we have in our mind that the trend line of
nominal GNP should be decreasing Over the 5-year period? Isn't that a
statement that we should make, understanding that as accidents happen
and situations come along we will adjust around that line and that
we're not shooting for it on an annual basis? It seems to me that's
in some sense what we've been doing here, or at least I've had that in
the back of my mind as we've been making policy.
CHAIRMAN VOLCKER. Mr. Corrigan.

M R . CORRIGAN. Well, I tend to be a bit eclectic about these things. I certainly think that price stability should be the preeminent goal of the central bank, but I don't think we can or
should attempt to state it in a way in which that is the only goal of
the central bank. I certainly don't think it would make good sense,
in any time frame that I can conceive as being relevant for making
policy, to state boldly that zero inflation is a goal in and of
itself. As a matter of fact, I think that would be a bear trap. I
don't think it would have any credibility, as I think Tony said very
well. But, even if it did, irrespective of fiscal policy and
everything else, I think a central bank has an equally important goal, and maybe it isn't as explicitly recognized, and that's financial stability. Put aside for the moment fiscal policy and deficits and crop failures. All those other things can be very important, but in
any context that I can conceive of, the other thing that the public
and the Congress and everybody else look for from the central bank is
financial stability. It's hard to define that. Obviously, that
doesn't necessarily mean a stable M1 or stable intexest rates, or
whatever. It's almost a state of mind rather than a statistic. I
think it would be a big mistake to frame goals in legislation or
otherwise that ignore that part of our existence that I think people
do look very, very directly and importantly to the central bank for.

-26-

I also have very, very serious questions, even in the intermediate term of 5 to 10 years, about this proposition that says monetary policy, however defined, only affects nominal variables. I have a great deal of difficulty with that. I know that if you read a hundred years of monetary history things seem to work out that way, but I have a great big question there. Being eclectic, if I were put to the wall in terms of having to try at least to build if not to convey a better mousetrap, I certainly would try to do it in a way that preserves the highest degree of flexibility for the central bank because I do think that the major part of our problem is and always will be coordination with other arms of economic policy--coordination that I think is a safe bet will not be forthcoming in most cases. That would lead me, if I were forced to do something in statute or otherwise different than what's there now, to move in the direction of paying more explicit attention to nominal GNP. But even in doing that, I personally would be inclined to do it in a context in which there were enough other things there--maybeeven money and credit targets associated with nominal GNP objectives so as to leave the greatest possible amount of flexibility, whether it's for one year or five .
MS. TEETERS. I was going to make Chuck's point that we seem
to have lost sight of where a lot of the inflation comes from. We
have had several supply shocks and we could probably face another one
if we have a crop failure. And that's very difficult for us to deal
with because if we prevent the price level from rising or prevent the wage level from rising, basically that means a redistribution of income to the agricultural sector and to the retirees who are indexed to the CPI. So, once we have that sort of shock, there's a problem in trying to unwind it. If you look back at 1973, the [rise in1 agricultural food prices transferred a full 1 percent of the nominal GNP to the agricultural sector. There was no increase in real output, and three years later finally their nominal and real were back
together again as a share of the total. So, there are income
distribution problems when we're dealing with inflation.

I also thought back over the oil shock problem. The amount of readjustment that was necessary was fairly massive, and it wasn't only short run. If we had tried to do it in a year or a year and a half, I'm convinced that we would have put the whole world into a major depression because we had to convert capital equipment to more energy conserving operations. Looking back, we can quarrel a little
about some of the timing, but I don't think we could have done that
adjustment in a period much shorter than the 10 years that have passed
since then. As Chuck says, we're going to live in a world in which we
have supply shocks of one type or another that we can't anticipate.
And if we're going to pledge ourselves to offsetting them totally,
we're pledging to be in a constant state of recession, as near as I
can see it.

MR. WALLICH. Bear in mind that between the first and second oil shocks, the whole world changed its mind. That is, we were all

-27-

pretty accommodative of the first oil shock and by the second we had
learned the lesson that it was too costly and resulted in too much
inflation, and then countries were much less accommodative.
MS. TEETERS. But we couldn't have done in 1974 what we did
in 1979. We had to have a period of time in which to conserve energy,
to change the base of the capital stock, and a few other things. The
timing probably was about right--toaccommodate it in the first
instance and crack down on it in the second.
VICE CHAIRMAN SOLOMON. Well, even though I agree with your
general proposition, I'm not sure I agree with the ideal timing of oil
[unintelligible]. I think it could have been earlier and we would
have had a faster adjustment.

M R . KEEHN. I think I heard earlier, perhaps incorrectly, that there was an agreement by this group that fiscal policy really doesn't matter. It seems to me that it really does matter. In my view, the problem here is that we have a fiscal policy that is irresponsible and running out of control. The Congress has a problem and they are understandably trying to shift the problem from their
desk to our desk. I think we ought to be very reluctant to accept
that responsibility. And, idealistically perhaps, I'd be in favor of
setting as the broad objective that we are trying to develop policies
that will provide an environment of price stability. To state as an
absolutely overriding objective that we're going to seek zero price
increases over any period of time might be difficult and
objectionable. But I certainly think we should state as our objective
that we are planning to reduce price increases over a period of time.
And I think that we should adopt goals and policies that are broad
enough, and ranges that are large enough, that we can have plenty of
room for operating latitude. But we'd make a terrible mistake to
accept any goals and objectives over which we don't have some real,
direct control as a way of taking on some responsibility that is
basically not ours, but rather is that of the Congress.

CHAIRMAN VOLCKER. Mr. Black. I'll get to the fiscal policy
question in a second here.

MR. BUCK. Mr. Chairman, as we approach this [unintelligible] in Congress, it might be helpful to draw a
distinction about one of the three different groups there. The first
group would be Reuss and Patman types of professional Fed baiters, and
there's nothing we can do other than hope that they don't persuade
other members of Congress that this is the word. Then we have gold
bugs like Xemp, and there's nothing the Federal Reserve can do about
that other than contribute to the dialogue that suggests that it
really can't work the way they think it ought to. So, what we're
really talking about is this third group of people in Congress, most
of whom seem to me to [believe] that we can have some important impact
upon the economy [by] manipulating real economic variables in the
short run to achieve desirable objectives. I think the way to deal

-28-

with that group--and that's the only one that we can practically deal
with--is along the lines that you did in your testimony before the
Fauntroy Committee, where you tried to talk about what we can and
can't do.
When we come to a meeting like this, we see very clearly that
there are a lot of differences of opinion among the members of the
Federal Open Market Committee about what we realistically can do and
what we can't do. As Bill Ford put it several meetings back, and you
agreed with him when he said it, Mr. Chairman: "Isn't the argument
between those who think we can manipulate real variables over the long run and those who think we can't?" And that's what has come out in this discussion today. I feel we really can't; I'm in the majority on that, but others have a lot of differences of opinion there. So, my preference would be, of course, to state that a zero rate of inflation is what the central bank ought to aim for. And I would add one other element, and that is to try to avoid [springing] monetary surprises that the economy doesn't expect. But that's not something that everybody here is going to agree on. So, as a practical matter, if we
are confronted with the necessity of suggesting what our goals ought
to be, which you seem to think we will be, I believe the only thing we
can get any great consensus on is along the lines that Lyle suggested
of aiming at a lower rate of inflation over time. That's compatible
with my one great objective and I could meet him at that common
meeting place.

MS. TEETERS. I had one other comment. There's some question
raised here about how we communicate with the public. I think we've
done a lousy job of it. I think we did a better job in our most
recent testimony when we talked about velocity and the relationships
with money and nominal GNP and the rest of it, but basically one has
to be able to read the code. One has to know that "slightly greater
pressure on reserves" means increased borrowing. The most fought over
decision in this room is never [statedl in the directive. The
borrowing assumption has been [the key decision1 the whole 5 years
I've been on the [Committeel, and we never tell anybody about it.
We're really not being open and honest. And what we've done has
created a whole profession out there who interpret this obscure
document of ours to the rest of the world. About 50 percent of them
are alumni and they get it wrong. It seems to me we could be much
more open about what it is we're trying to do and how we're actually
operating day-to-daymonetary policy. And I will repeat: I see no
reason for keeping the directive secret for six weeks. And the recent
leaks only reinforce my position on that point.

MR.

FORD. You have two iiHearears" down on this end
h

MR. BOYKIN. Is the real problem, Nancy, the fact that we are not saying it or is the real problem the results of what we're doing?

MS. TEETERS. I think a lot of the problem is the fact that
we are not telling the public what we're actually doing.

-29-

MR. BOYKIN. Being in the hinterland where I am, trying to listen to what you might be hearing in Washington, it appears that all the efforts currently underway are an expression of dissatisfaction with the Fed because of the results of what has happened to the economy. When you get to the Congressional or the fiscal policy side,
these seem to me to be attempts to make the Fed conform to the wishes
of those in Congress who are being "irresponsible." It seems to me
that we find ourselves in the position of trying to minimize all the
bad that everybody else is doing.

MS. TEETERS. Well, I think two things are going on here.
One is a short-run problem--nottelling anybody what we're doing. And
certainly, the events of the past three weeks-­

CHAIRMAN VOLCKER. Look, I just have to interject here. I
totally disagree with this. The one borrowing figure that you're
concerned about people see published every Friday. We can't be more
explicit than publishing a figure that says borrowings last week were
$797 million and excess reserves were so and so.

MS. TEETERS. Then why was the market so upset the past few
weeks because they didn't know what the Fed was aiming for?

CHAIRMAN VOLCKER. They're always going to do that, whatever
we tell them. They're going to say: What are,yougoing to be doing
tomorrow?

MR. GRAMLEY. I do think, though, that we're going to be faced with a demand by the Congress to be more forthcoming. It seems to me that there is a strong trend in the Congress in that direction and then the question is: How should we try to shape the real-­

CHAIRMAN VOLCKER. That's different than on the operating
decisions, though.

MR. GRAMLEY. Right, but how should we try to shape the request in ways that minimize the damage to us? I think the answer is clearly to be just a bit more forthcoming and I suggest that perhaps what we ought to do is set some objectives for nominal GNP--nominal only. To go beyond that is very risky.

MR. FORD. Yes, I agree. What do you say? A c you putting le [it in terms of1 a ceiling or a range? MR. GRAMLEY. I would use a range. I have my program for optimality for the next five years--for1984 to 1988. I'd start off with a nominal GNP range of 8 to 10 percent for '84 and get down to 6 to 8 percent--a 1/2 percentage point treductionl per year. That conforms with the Administration projections for real output at 4-1/2 percent and a string of 4 percents and inflation that starts at 4-1/2 percent and tracks down to 3 percent. That's a reasonable hope for the economy. It's a range that we may have to revise at the end of

-30-

1984 if it doesn't work out; we can tell [Congress1 that we're going

to have to reinitialize each year.

M R . CORRIGAN(?).

Base drift.

CHAIRMAN vOLCKER. I don't think we can get by with that as a
practical matter. We might get by with saying we will put the
emphasis on nominal GNP, but immediately they're going to say: Divide
it up. What do you think that means for prices and real growth? We
might get by with that being the subsidiary, but we're not going to--

MR.

GRAMLEY. They're going to push in that direction.

VICE CHAIRMAN SOLOMON. You have 3-1/2 percent [inflation]
for next year or the year after. What happens if next year we hit
5-1/2 percent? What would you say then?

MR. GRAMLEY. We reinitialize. We say things didn't work out the way we anticipated. They don't always. We warn people ahead of time that when we set an objective for nominal GNP we might not make it. We certainly don't k n o w in any precise way how that GNP is going to be distributed between prices and output.

VICE CH?+IRMAN SOLOMON. Not only is it intellectually dishonest, but I don't even believe that having a long-range price stability target requires us to project a continuous reduction in the rate of inflation every single year. That's not realistic. We can have a long-run objective of price stability and still recognize various price rigidities in the economy, such as changes in the oil supply/demand situation or other things. We don't project
automatically a half point [reduction] or whatever it is every single
year. Wouldn't you agree with that?

MR. GRAMLEY. I don't disagree at all. What I'm saying is that I think Congress is going to force our hand to be more forthcoming on something. Then the question is: What can we do that will be least damaging from the standpoint of the Fed and least damaging from the standpoint of the formulation of economic policy generally? And I think the answer lies in focusing on the variable among the nonfinancial variables that is the most immediately amenable
to influence by the Fed, which is nominal GNP, and then capitalizing
on the fact that if our objective is to reduce the rate of inflation
over time, we ought to alert the public that what we plan to do is to
bring down the rate of growth of nominal GNP to a rate that ultimately
will be consistent with price stability. No, I don't think we can
promise that we're going to have growth rates of nominal GNP that are
going to be half a percentage point less year after year; that's quite
unrealistic. I don't expect that.
MR. BLACK. That meshes very nicely with what we've been saying ever since we started our October 6, 1979 procedures except that we're now only suggesting talking in terms of nominal GNP rather

-31-

than [monetary] aggregates. I would prefer to talk in terns of the
aggregates, of course, but this is certainly compatible with what
we’ve always said.
CHAIRMAN VOLCKER. Well, let me shift, for a few minutes
anyway, to the other part of the equation. I suppose we would all
agree in varying degrees that fiscal policy has some effect on the
economy. That’s not the question I want to explore. What are the
implications of fiscal policy for monetary policy? Quite concretely,
just imagine that Congress comes in some day--say,after they come
back from their recess--andsays: We’re going to pass a [$SO1 billion tax increase, all other things equal, but we expect a little quid pro quo from monetary policy. What do we say?
M R . MORRIS. Good. What they’re really interested in is interest rates, and we tell them that if they increase taxes by $50 billion or so, interest rates will go down.

CHAIRMAN VOLCKER.
M R . WALLIM.
MR.

How much?

Well, if we told them--

RICE. We know the direction. MORRIS. We know the direction of movement.

MR.

CHAIRMAN VOLCKER. [Congress would sayl: I’m not satisfied
with that, Mr. Morris. You tell me they’re going to go down by 2
percentage points and I’ll sign off. Are you going to guarantee me
that they‘re going to go down 2 percentage points?

MR. PARTEE.

A guarantee is what they want.

MR. WALLIM. Will they take the responsibility for the inflation that results?
MR. PARTEE.

Inevitably.

M R . WALLICH. We’d have to raise the money supply by 3 percent, let’s say, and over time that will give us 3 percent more inflation.

CHAIRMAN VOLCKER. They’d probably take that

MR. PARTEE.

And get voted out of office.

M R . MORRIS. Yes, but we’re not going to trade off an increase in the money supply for a reduction in taxes. M R . PARTEE. M R . MORRIS.

All right. But that’s the question, I think

Now, that doesn‘t--

-32-

MS. TEETERS. What I think we really want to look at--orat
least what I look at--iswhat the standardized structural full
employment deficit surplus is relative to the economy. In my own mind the proper place for that to be is someplace around plus or minus 1/2 percent of potential GNP. If they come back with a $50 billion tax increase, that still leaves us with a growing structural deficit that gets out of hand. It is not enough. Now, I happen to agree with your
point and I know it's terribly difficult to sell. But if they reduce
the deficit, interest rates will come down automatically. But that
doesn't give us much bargaining [leverage] when we get to a summit.
So, we really have to figure out more or less what we're willing to
pay in monetary policy to get some correction in the fiscal policy.

MR.

ROBERTS. If they start increasing the deficit, interest

rates-­ VICE CHAIRMAN SOLOMON. I'm being semi-facetious and semi-
serious: I'm not sure we actually have to give them a number.
SPEAKER(?) I don't think we do either.
VICE CHAIRMAN SOLOMON. we could say, of course, that to the
extent they reduce fiscal deficits, that's obviously an anti-
inflationary action. We will carefully assess that and we believe
that that would give us room for easing monetary policy to a degree.
CHAIRMAN VOLCKER. What does that mean--highermonetary
aggregates?

M R . MORRIS.
MR.

Lower interest rates

RICE. Lower interest rates.

VICE CHAIRMAN SOLOMON. Because if they're taking anti-
inflationary action, we will not necessarily get higher monetary
aggregates with lower interest rates.
CHAIRMAN VOLCKER. You're interpreting Federal Reserve easing
to a degree as lower interest rates?
VICE CHAIRMAN SOLOMON. Yes.

MR.

ROBERTS. No expectational factor at all?

VICE CHAIRMAN SOLOMON. I think that's what they're looking
at, yes.
CHAIRMAN VOLCKER. All right, now let me just pursue this.
VICE CHAIRMAN SOLOMON. I haven't studied these deficits.

-33-

CHAIRMAN VOLCKER. I understand, but let me pursue it a bit.
They say: You're going to give us lower interest rates. In their
terms, it's you're going to give them to us. I say, yes, I think
that's the direction in which rates will go. We may not have to give
them 2 percentage points but they say: Yes sir, but are you going to
tell us that the full powers of the Federal Open Market Committee are
going to be directed toward assuring that there is a noticeable
decline irinterest rates when we're going to go through all this
political agony of--probablyrealistically--a$15 billion tax
increase?
VICE CHAIRMAN SOLOMON. Actually, $15 billion doesn't buy
anything.

MR. PARTEE. Maybe 10 basis points.

CHAIRMAN VOLCKER.

[They'll say:] Then why should we do it?

MR. GUFFEY. You have to start from the premise that interest rates are going to be higher if they don't do it. And if our objective is price stability some time in the longer run-­

VICE CHAIRMAN SOLOMON. It gives us more room to encourage
interest rate reductions if they are taking that kind of anti-
inflationary action. But I don't think under any conditions that we
can give them an order of magnitude. It depends on so many other factors, obviously.
MR. WALLIM. Well, if one could engage in some fine-tuning, one could say we'd raise the rate of money growth for a year because the tax increase will have some downward impact on the economy. The
decline in interest rates that comes from that will not completely
offset it, so there is some net downward response by the economy. If
one dares to fine-tune, monetary policy can offset that [response].
But we must not get trapped into a permanently higher rate of money
growth. Everybody understands that that means more inflation.

SPEAKeR ( ? )

. Maybe, maybe.

MR. PARTEE. This can get to be very complicated though, Henry. It depends on the kind of tax increase. You remember in 1968 when we very, very desperately wanted a tax increase to help finance the war in Vietnam we got a 10 percent surtax in the middle of 1968 and then the Chairman or the Board or the Committee--I'm not sure who --came as close as they could to promising a reduction in interest rates if that 10 percent surtax went in. It went in and I'll be
darned if interest rates didn't start to go up rather than down. And
it was a great, great political problem. So, we do have in modem
history a representation of the kind of trap that I'm sure Paul has
very much in mind.

-34-

MR. GRAMLEY. And the worst part of that story is that we led the parade with a decline in the discount rate. We kept-MR.
IL.

PARTEE. We went out to Minneapolis and got them to cut

MR. GRAMLEY. We kept trying to pump in enough money to make sure that interest rates didn't go back up. The 10 percent surcharge had no fiscal restraint effects at all. The monetary stimulus had a lot. we ended up with the worst of all possible worlds. MR. BLACK. Wasn't that the occasion on which Hugh Galusha said that was not a vast [decrease] in the discount rate but rather a half vast [decrease]?

MR.

PARTEE. I think we only got a quarter. Wasn't that the occasion?

MR. BLACK.

CHAIRMAN VOLCKER. It's not clear to me how I can participate
in this subject.

c

SPEPXER(?).

You must tell them about 1967.
[Unintelligible1 the tightening we've been

CHAIRMAN VOLCKER. doing, the heck with it.

MS. TEETERS.

It wasn't big enough.

MR. PARTEE. Well, I don't know. People trotted out the permanent income hypothesis to explain why it hadn't had much effect. You can say that to a Congressman, you know: This didn't really do anything because it didn't affect permanent income.

CHAIRMAN VOLCKER. I'd get the same answer I got before
Fiscal policy, then, shouldn't affect what we do.

MR. RICE. I don't agree with that. It's bound to affect it. If we do get a substantial deficit reduction, there is room left for reducing interest rates. And I think we should use that room.

MR. GRAMLEY. I think there's a difference between what we [can] do and what we [canl say. I agree with Emmett completely. I don't see how we could possibly talk about major changes in fiscal policy and say: Well, we're just going to ignore it. That's just not an acceptable way to look at it analytically, or empirically either, as far as I know. On the other hand, we can't promise Congress anything. If we do, we're likely to end up trapping ourselves into
committing the Federal Reserve to a course of action that later on
we'll regret. And we're going to send you up to explain that too!

-35-

CHAIRMAN VOLCKER. That‘s the only thing that‘s perfectly
clear!

MR. RICE. But I think we could possibly spur them on without promising in blood, which I think is Tony’s point.

VICE CHAIRMAN SOLOMON. We could point out that long-term rates will respond on their own and we would encourage short-term [rate reductions1 as long as we can see that the inflationary situation is still under control. I don’t see how we could give them a number or an order of magnitude.
CHAIRMAN VOLCKER. It doesn’t work. W o else has some wisdom h to cast on these subjects? Well, the obvious point, just relating it to the discussion tomorrow--andsomebody raised it before, the fiscal policy side in particular--isthat we have all these forecasts of
inflation going up, except our staff’s,and I guess they are
retreating a bit.
VICE CHAIRMAN SOLOMON. Yes, they’ve moved it up.

MR.

KICHLINE. We can‘t control the weather.

CHAIRMAN VOLCKER. Making it unanimous, we all want to get to
price stability. We’re facing a barrage of forecasts that say we’re
going to go [away from1 price stability by a trivial amount in the
[near] term or by a larger amount over the next two or three years.
Now, if I listened to all of you earlier, we ought to be tightening up
[over time], except for the [immediate] operational decision. But it
sounds to me, if that long-term [objective] is meaningful, that we
ought to have at least a little more chance of getting things on a more satisfactory trend. Am I misreading this earlier [discussionl?
MR. BLACK. That’s a real good starting point; I hope you lead off with that in the [morning].
MR.

ROBERTS. Right on!

VICE CHAIRMAN SOLOMON. Well, I’d like to dissent.
MS. TEETERS. Yes, so would I.

MR. PARTEE.

Yes, I don’t know about that.

MR. GRAMLEY. Well, I could agree in principle. That would be a very good idea not to let any supply side shock get built into the underlying [inflation ratel.

CHAIRMAN VOLCKER. Well, that supply side shock is a bit of a
cop-out. Except for Jim’s, all the forecasts were that way before the
weather got hot.

-36-

MR. GFAMLEY. But that may well be a problem we have to face in 1984. It may well be that instead of food prices going up 7 percent or so at retail, they will go up twice as much.

CHAIRMAN VOLCKER. That may be, but Z'm not facing that. Forget about this food thing. We're facing a situation where prices are going up because the economy is recovering and there are a lot of temporary [upwardl influences--thedollar is going to come down and so forth and so on. VICE CHAIRMAN SOLOMON. Most people in this country, if
they're no longer fearful of inflation continuing to increase and
getting into the double digits, have it down in the 4 to 6 percent
n area. I'm not talking about the FOMC necessarily, but most people i
this country seem to reflect that.
CHAIRMAN VOLCKER. We're not most people.
VICE CHAIRMAN SOLOMON. [I] would argue that in today's
conditions we already have a such a high level of real interest rates
that we would not [want to] tighten further at this point. I just
don't see that it's realistic for us to pin ourselves to a 5-year
target with a track in the Znd, 3rd, and 4th years that we're not
going to be able to follow or come anywhere near.

MR. CORRIGAN. If we're at a point now where the cyclical low in the inflation rate is--pickyour own number--3-1/2to 4 percent, and we're talking about the inflation rate moving up in 1984 to 5 or 6 percent, depending on whose numbers you look at, is there any realistic chance to expect that the inflation rate in a cyclical upturn can "stabilize"at 5 or 6 percent? Or are we looking at a
situation whereby the very dynamics of the process inevitably involve
the cyclical peak in inflation being 10 or 12 percent with the central
tendency being halfway between the current cyclical [low] of 3-1/2 to
4 percent and the cyclical peak of 10 percent? In that case we're
saying that the long-run average rate of inflation is 5 or 6 percent
rather than 0 to 2 percent. That in some sense or other is what was
being talked about in the earlier discussion. From my perspective, at
least, that's the real dilemma. Because if we are looking as far out
into the future as we can and see a situation in which the inflation
rate is going to vary cyclically between 3-1/2 and 10 or 11 percent, I
think the implications of that in terms of interest rates and the
behavior of the economy and everything else are pretty darn lousy.

VICE CHAIRMAN SOLOMON. I think you're going into an
unnecessary extreme of pessimism. It's very likely that wage
decisions can stay in an area, even with a total business cycle
recovery, that's compatible with 4 to 6 percent inflation. I don't
see that the American labor movement is going to take the bit between
it's [teeth]--. If we do our job with a certain degree of vigilance,
then I don't see that we have to think in terms of going back up to
the 10 to 12 percent inflation level.

-31-

M R . CORRIGAN. But even by that you're saying that the longrun rate of inflation in your little model is something like 4-1/2 percent.

MS. TEETERS. Also, Jerry, I think the world oil situation is
very different than it was in the last two cyclical recoveries.

MR. CORRIGAN.

I don't think-­

MS. TEETERS. We'll get some of it back, but I don't think
that we're going up to full capacity.

MR. CORRIGAN. Both of those points are good points. I'm not predicting the kind of thing I just mentioned, but it's a clear danger once you've experienced it, even though oil and other things had something to do with it. I just don't think we can afford to dismiss the possibility that once we get to whatever the number is--6 or 7 percent--thatwe will then have the [inflationary] momentum built in. It almost guarantees that that kind of very unhappy situation could result. MR. ROBERTS. Well, I know it's partially cyclical, but we have an environment out there that I think is an opportunity of a lifetime to start toward price stability. Businessman after businessman tells me: When I put in a little price increase, it gets
knocked down. And yet his margins are good, his unit volume is
expanding, and his profits are good. If ever we need an appropriate
monetary policy, which is how to keep the prices down, it's now--on
top of this situation.

MR. MARTIN. It's not only the price experience, Ted. I think you'd agree that it's the changes that have been made internally in company after company after company: They are cutting down staff; there are concessions by the labor unions and by the work force. The potential for productivity in the next few years is very different from that in the years of the 10 or 12 percent inflation.

MR. RICE. But some price increases are beginning to stick-­ the recent aluminum price increase, for example.
MR. ROBERTS. The commodity prices are coming back. One fellow told me it would soon be back to cost. We're going to have that sort of thing; but the price competition is very vigorous in any business I can find.
MR. MARTIN. Some prices are sticking and some are not. Lumber prices came cascading back down.

CMLIRMAN VOLCKER. Let me just ask a nice neutral fellow like
Mr. Kichline. What did you think of what AT&T agreed to apparently?

M R . BALLES.
15 percent.

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MR. MR.

KICHLINE. I think it’s a good agreement. PARTEE. For whom?

MR. KICHLINE. In the climate--inthe context of the discussion here--1would view it as a good agreement. I don’t have a lot of detail. But pricing it out, I think it is something in the area of 16 percent over 3 years: a 5 to 5-1/2 percent wage increase now; 1-1/2 percent in each of the two following years; and a COLA that‘s worth something like 75 percent of the CPI, but once a year. There are two COLAS involved. So, if you assume 5 percent inflation-­

CHAIRMAN VOLCKER. The COLA is only worth
MR.

75

percent?

KICHLINE. Something like that.

VICE CHAIRMAN SOLOMON. And also, they have a very high level
of productivity.

MR. KICHLINE. Now, in the communications industry in total-­ the last numbers were for 1981 with preliminary numbers for 1982-productivity has been going up year in and year out at something like 6 percent per year. That’s an industry in which 16 percent doesn’t look that bad.

CHAIRMAN VOLCKER. All right, you say 16 percent, which is
apparently the wage part of the settlement. What’s the rest of it
going to have to-­
VICE CHAIRMAN SOLOMON. The second and third years it’s 1-1/2
percent plus the indexation.
CHAIRMAN VOLCKER.

I know, but what about pensions?

MR. KICHLINE. My understanding was that they did not get very much on employee benefits. That’s the area that’s a little fuzzy. The company, I think, had been pressing for the employees to pick up more of the cost of health care and other things, and they gave up on some of that. But on some of the key issues that the union was desperately concerned with--namely,employment security--it‘sour reading that the company retained its options. That is, they’ve agreed to retraining in attempts to place affected employees but in a sense did not lock themselves into work rules that would make it very difficult for the future. And I view that as very positive.

MS. HORN. I would underline that. It seemed to me that the
issue that the company really won on was the work rules issue, which
was the issue they could not afford to lose on. That’s an industry
that is changing rapidly and a company that is changing rapidly, and I
think that was a significant step toward increased productivity and
keeping--

-39-

CHAIRMAN VOLCKER. Did they get some positive work rule changes? I didn't see that anyplace.
MS. HORN.

No, I wouldn't say that. They avoided some very

bad ones. CHAIRMAN VOLCKER. They avoided some bad ones.

MR. PARTEE. Let's assume that it is 5-1/2 percent and that productivity is rising 5-1/2 percent in the telephone [industry]. Is 5-1/2 percent a good settlement as a standard-bearer for the country as a whole?

CHAIRMAN VOLCKER. think it's a bad one.

MR. KICHLINE.

I didn't say it's [not] a smart one, but I

Zero unit labor costs are bad?
5-1/2 percent.

M R . PARTEE. No.

CHAIRMAN VOLCKER. I don't know. Nobody else is going to go
looking at the productivity in the telephone industry, assuming it's
there. They are going to say that the telephone workers in the bottom
of a recession settled for 5-1/2 percent and they want more than that.

MR. ROBERTS. But if they didn't get job security and they don't have the productivity, they won't have a job. I think that comes across.

VICE CHAIRMAN SOLOMON. Besides, I don't know if it's that much of a standard-bearer because the manufacturing industries and unions think of it as being a regulated situation and quite different.
MR. PARTEE. I do think people would view it as something to exceed--that the telephone industry is a dull industry and [other workers] ought to do better.

CHAIRMAN VOLCKER. It's getting unregulated.

MR. MARTIN.

It used to be a dull industry; now it's a

competitive industry.
M R . CORRIGAN. Part of the productivity problem, though, is that every businessman or woman we talk to will tell us that their productivity has grown like gangbusters. Even in industries that are suffering, they're talking about these great increases in
productivity. I don't know who is holding productivity down in the
aggregate statistics, but at the micro level it's grown like the devil
every place.

CHAIRMAN VOLCKER. What inflation rate are you assuming when
you say that the wage increase is 5-1/2 percent?

-40-

M R . KICHLINE.

A 5

percent C P I increase.

VICE CHAIRMAN SOLOMON. Putting aside commodities for a moment or any possible oil price increase, I think the inflationary push--theinitial manifestation--isgoing to come more from the ability of industry to get even higher margins by putting forth price increases as sales pick up and capacity gets near [full] utilization. Then labor will follow in a year or so and start pressing for wage
increases greater than productivity increases. At the moment, unit
labor costs are probably not rising significantly at all.

MR. ROBERTS. Don't forget that almost every major industry is really affected by import competition, which is making them not raise those margins as much as they otherwise would. That's another thing that's a universal chorus that we hear: that the foreign competition is just deadly. MR. WALLIM. These very high profits, which surely must be an incentive [for workers1 to raise [their wage1 demands-­

MS. TEETERS. Are they high or just rising rapidly? After all, they were very depressed.
MR. WALLICH. I mean that the share of profits in GN'P is abysmal but the rate of increase is terrific. CHAIRMAN VOLCKER.

Well, does anybody have any more comments?

John.

Well, Paul, this is backing up to where we were You asked a question. I don't think you got a very good answer from anybody, at least from what I heard, on this very tough question of: I f the Congress says to you they are willing to increase taxes by Sx billion, what are we going to do? I find that a very tough one to handle and I only got a little glimmer of how you might be able to [respondl. I think I'd try to hang my hat on the full employment budget concept. Sure, the literature of economics is full of talk about getting a better mix of fiscal/monetary policy. And a lot of learned observers of the economic scene say that what we need is tighter fiscal policy and easier monetary policy and not such an extreme case of a highly stimulative fiscal policy and a highly restrictive monetary policy. But if what [Congress1 is talking about
is a $15 or $20 billion tax increase, that is still going to leave us
with an extremely large full employment deficit in the federal budget,
and we would consider it imprudent to be more expansive in the rate of
growth of the money supply until we get to the point where the full employment budget is actually in surplus or we at least have a far smaller deficit than the figure that would exist even with a $15 or $20 billion tax increase. And, therefore, we would not propose to ease up at this time until we are a lot closer to a balance in the full employment budget.
MR. BALLES.

10 minutes ago.

-41-

CHAIRMAN vOLCKER. Well, the trouble with that argument is
they would say: Well, then, we'll forget about it. If you're not
going to do your part, then why should we go through all the sweat in
the year before an election?

MR. BALLES. Well, I think it's a good answer. While I wouldn't guarantee it, you've already said that if they were to cut--1 forgot the numbers you used but it was some big drop in the federal deficit of $70 billion or $50 billion, I think-MR.

MARTIN. He said take $50 billion, for example

M R . BALLES. You said in a qualitative sense that it's almost certain long-term interest rates will come down a couple of points.

CHAIRMAN VOLCKER. I didn't say almost certain, John. Mr.
Kichline has an astute econometric analysis to prove that after the
fact.
VICE CHAIRMAN SOLOMON. There is a different tack you can
take, Paul--thatyou were thinking of tightening, and then afterwards
you could say that you couldn't carry a majority at the FOMC meeting.

M R . CORRIGAN. You could always raise the discount rate now so you could lower it then.
MR. PARTEE. I think the Greenbook shows at 6 percent unemployment-­

CHAIRMAN VOLCKER. We could raise the money supply so we could tell them they wouldn't want us to be more expansive than this, [unintelligible1 . MS. TEETERS. The full employment [deficit] as a share of GNP
is rising by about what--1/2percent for the forecast period?
CHAIRMAN VOLCKER. Why in this Greenbook do you keep calculating the full employment deficit at [ 1 5 percent [unemployment a rate1 ?
MR. KICHLINE. MR. PARTEE.

That's the official number.

It's at 6 percent in the footnote.
I know. But why don't we put 6 percent in

CHAIRMAN VOLCKER. the table?
M R . KICHLINE.

We have both.

CHAIRMAN VOLCKER. I know you have both, but my question remains: Why in the table do you put 5 percent?

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MR.

KICHLINE. It’s the official series.

MS. TEETERS. It’s the official number.

M R . KICHLINE.
MR.

We could easily eliminate it

PARTEE. That is done per my request of a couple of years

ago.

CHAIRMAN VOLCKER. I didn’t know we had an official series

MR.

MARTIN. We‘ll change the official-­

CHAIRMAN V0LCKF.R. We’ll make it official Federal Reserve or
official FR Confidential.

MR. MARTIN.

6 percent.

MR. PARTEE. Anyway, in the forecast it’s $106 billion in the fourth quarter of 1984.

CHAIRMAN VOLCKER. That‘s for 6 percent or 5 percent?

MR. PARTEE. That’s for 6 percent. So, if it gets down $20 billion, we only have an $85 billion full employment [deficit].

CHAIRMAN VOLCKER. Well, the practical political problem is
that they will say: We‘re not going to bother doing anything. That
seems like a big deal to them.

MR. BALLES. Well, it seems to me the practical answer, Paul, is what you already gave before: that that would very likely reduce interest rates. If they want to get interest rates down, this is the most promising way of doing it. MR.

MORRIS. But they have a $100 billion problem and not a

$15 billion problem.

CHAIRMAN VOLCKER. Well, we’ll send somebody else to negotiate with them. I’d like to have an executive session. Mr. Cope--. [Secretary’s note: The executive session was not transcribed.1 [Session recessed1